Financial intermediation and economic growth in the East African Community: A financial index approach

Abstract

Despite the abundant literature on financial development and economic growth nexus, the debate is far from settled. In this paper we create a financial development index using principal component analysis (PCA) and use it to examine the effect of financial intermediation on economic growth within the East African Community (EAC) using panel data over the period 1985-2017. The DOLS and FMOLS models are estimated since they control for heterogeneity, serial correlation, small sample bias and endogeneity in the presence of long run relationship. The results indicate that financial intermediation has a positive and significant effect on economic performance of the EAC countries in the long run. Among the controls, capital formation and FDI also have positive effects on growth while the growth of the population reduces the per capita income.